Know the Cost of College Loans

The more you save now, the less you will need to borrow later to cover the cost of tuition, books and expenses. If you haven’t saved, or your student isn’t receiving a full-ride scholarship, borrowing may be your only option.

Loans are borrowed funds that must be paid back with interest (or paid back before interest begins to accrue). There are two broad categories of student loans—federal student loans, which are administered by the U.S. Department of Education, and private student loans, which are non-government loans issued by non-governmental lenders, including banks, credit unions and companies such as Sallie Mae.

Federal student loans come with strict eligibility requirements and borrowing limits, but they traditionally offer several advantages over private loans. For example, federal student loans charge a fixed rate of interest, and payments on principal typically are deferred until six months after the student graduates.

Interest on federal student loans begins to accrue when the proceeds of the loan are disbursed to the school—but students who demonstrate financial need may be eligible for a subsidized federal student loan, meaning the government covers (or subsidizes) the interest as it accrues until the deferral period ends and the student starts repaying the loan. With unsubsidized federal student loans, borrowers can choose to pay the interest as it accrues or allow it to “capitalize.” In other words, the interest rolls into the principal balance, compounding your overall debt. Capitalization can be costly in the long run because, when you begin repaying the loan, you start out with a higher principal balance—and so you wind up paying more in interest over the life of the loan.

Private student loans usually charge variable interest rates that are often higher than those available for federal loans. In addition, origination and disbursement fees can be high, interest accrues (and is often capitalized) during the student years and repayment options tend to be more limited and less flexible. For example, you might not be able to defer payment on a private loan if you decide to go to graduate school.

Smart Tip. Regardless of income, parents and students should research—and exhaust—federal student loan options before turning to private loans. Not all federal student loans are based on demonstrated financial need. Ultimately, if you apply for a federal student loan, you will need to complete a FAFSA form.